NASDAQ vs. A/D line (overlap,) 2-year daily chart
Individually, the vast majority of "market forecasting systems" and "trading systems" on the market today have limited usefulness – something you may know from first-hand experience.
Most are – to put it mildly – inaccurate. Worse, those financial advisers who are occasionally correct in predicting broad market trends don't help you profit from them – because when it comes to finding individual stocks to capitalize on those trends, they haven't a clue.
On the other end of the spectrum, there are many technical trading systems out there. And some of their charting techniques are quite useful for finding bottoms and tops.
But the problem is they don't tell you where to focus your attention. You gain some charting techniques to help you time trades. But they don't tell you which markets, sectors, or stocks to look at.
My Internal Strength System combines the best of both worlds, and the flaws of neither.
First, I'm going to help you understand that there are, in fact, two stock markets out there ...
One is the external market, the market that most investors see day in and day out.
This includes the S&P 500, the Dow Jones Industrial Average and other major indices.
The "external market" is the stock market that most people use to tell them what already happened. It's also the stock market that's responsible for most investors losing money on the vast majority of their trades.
But right beneath the surface of the external market is what I call the "internal market," and that's the market you need to understand to grow very, very rich.
Turn on the TV and the radio, and what's the main financial news of the day? It's whether the Dow is up or down, and how many points it rose or fell.
The Dow Jones is what the "Joe Investor" uses to identify the market's trend and risk. But it's a highly inaccurate indicator. Not only is the Dow Jones average disproportionately price-weighted ... but it is based on only 30 stocks!
You could turn to the S&P 500 to get a clearer picture of the market's internal strength. But again, watch out!
The S&P 500 is based on 500 stocks, not 30. But the biggest 50 stocks make up half the weight -- and contribute to half the index's movement. So, tracking the S&P 500 doesn't give you a fair picture of where the market is heading, either.
I reveal the only way I know of to truly gauge the market's inner strength, direction, and risk ... and believe me; it has nothing to do with watching the Dow or S&P 500.
Let me give you a sneak peek into how we determine that the external market is showing strength as the internal market is breaking down.
The chart, illustrates the Nasdaq Composite Index (which represents nearly 3,000 stocks that are traded on the Nasdaq Stock Market) and it illustrates that index's Advance / Decline line (we'll call it the "A/D line" for short) which is overlapping the Nasdaq.
The A/D line is the squiggly red line that's higher on the left side of the chart and then falls below the black squiggly line (which represents the Nasdaq Composite) on the right side.
I've put some blue arrows on the right side of the chart to clearly point the A/D line out to you.
What the A/D line shows us is the cumulative difference of the number of advancing stocks vs. declining stocks. On any given day when a larger number of stocks increase in price, the A/D line moves higher. And on days when a larger number of stocks decline, the A/D line moves lower.
The direction of the line as it relates to the movement of the Nasdaq is what's most important to us.
When the A/D line moves in the opposite direction of the Nasdaq (or any other index for that matter), the index usually ends up following the direction of the A/D line.
So, if the Nasdaq is going higher and higher, but the A/D line is falling lower, that tells us that only a small number of stocks are responsible for the increase in the index. It's a sign of weakness.
If the Nasdaq goes up, and A/D line goes down, we call it a "divergence." A divergence works the other way around too... if the index goes down but the A/D line goes up. But, in that case, it's a sign of strength.
Now focus your attention on the right-hand side of that chart.
You can see that the new highs made by the Nasdaq (circled in red) are not being confirmed by the A/D line. This is a huge red flag. It means that fewer and fewer stocks are actually responsible for pushing the Nasdaq higher.
Near the first two blue arrows, you can see that the A/D line was making lower highs while above that the Nasdaq made higher highs. That was followed by a big drop in the Nasdaq which is indicated with that vertical pink bar.
Can you see above the last blue arrow that there's an even larger divergence? What do you think is going to happen next?
If you said... the Nasdaq is going to go down, you're correct.
That's exactly what happened. And thanks to the A/D line, we were able to predict that and profit from it.
Now, don't just run out and start betting the farm on market moves based on the A/D line.
There's another simple indicator that you must look at first in order to confirm what the A/D line is telling you about the direction of the real market.
Once you learn how to do this, you'll be able to make money, while the market is dropping.
For example...
Back in October 2007, the external market was running and gunning. The S&P 500 reached a high of over 1,565 ... the Dow had broken 14,000 and was heading higher. Everything was positive, and individual investors were pouring tons of money into stocks.
But behind the scenes, it was a different story altogether. My internal market indicators, including the A/D line, were flashing warning signs, telling me that the REAL stock market was showing serious signs of weakening.
What did I do? I pulled the trigger on numerous bearish trades – I took positions in stocks and options that enabled me to make money from the drop in the stock's price.
Just as I expected, the external market (S&P 500) lost more than 3% over the course of two weeks. During that period, while most investors were seeing red, our positions were up 13%, 26%, 25% and 47%.
It wasn't magic or a lucky guess.
The point here is that I knew that move was coming because of a few, very simple indicators that I look at each day confirming the direction of the internal market.
The most important thing for you to remember is that the internal market LEADS the external market.
No comments:
Post a Comment